Pages

Wednesday, June 18, 2008

In a recent roundtable address to the Productivity Commission, you described how two fundamental ideas of mainstream economics - the rational actor model and the idea of individual freedom - are scientifically outmoded ideas. You reminded the audience that these ideas originated in the 18th and 19th century ¡when we knew far less about human behavior than we do today.¢

Can you elaborate on this point and what caused your initial questioning of some of these mainstream economic laws?

When you examine conventional, neoclassical economics with a critical eye you soon realise it’s very much a product of the prevailing philosophical and scientific orthodoxy during its formative period, roughly between the publication of Adam Smith’s Wealth of Nations in 1776 and the publication of Alfred Marshall’s Principles of Economics in 1890. It’s thus a product of the Enlightenment, utilitarianism, the liberal philosophy of JS Mill, Newton’s physics and belief in the perfectibility of man. Since then economics has been following its own path, surprisingly little influenced by more recent philosophical inquiry and scientific discovery, except perhaps for developments in mathematics. So economics entered its tunnel when two disciplines highly relevant to the study of influences over human behaviour, psychology and sociology, were in their infancy. Had it branched off a lot later, I’m sure it would have had a more realistic model of behaviour in the economic domain.

The rational actor model probably seemed to make a lot of sense during the 19th century, but it takes no account of what psychology, sociology and neuroscience have taught us about the evolution of the brain, the tendency for instant instinctive responses to precede more considered responses and thus the key role played by intuition and emotion. Something I believe is a lot less widely recognised is the way the elevation of individualism over communitarianism - the barely disguised libertarianism - rests on the assumption of rationality - that is, on the belief that humans rarely make decisions they subsequent regret and rarely have trouble controlling their desires. Libertarians’ insistence that the state could never know what’s in my interests better than I know my self, thus making a case for minimal intervention in markets and minimal taxation, is unarguable - provided I’m always rational and rarely make mistakes or have trouble controlling myself. Once you accept that people often come to regret their actions and have trouble controlling themselves, you open up the possibility that governments may know better than the individual what’s in the individual’s best interests. More to the point, you open up the possibility that many of the restrictions governments impose on our behaviour are made with our tacit consent. We accept, for instance, that obliging cars to drive on the left, imposing speed limits, compulsory seatbelts and random breath tests are in our own interests as well as the community’s interests. There are huge areas of compulsion - of government restrictions on the liberty of the individual - that are utterly uncontroversial.

I came eventually to questioning these mainstream economic views partly as a result of getting older and wiser, but also as a result of the wider reading I’ve done in psychology - and, to a lesser extent, sociology - in more recent years.

Question 2

You have written several columns on alternative approaches to the study of economic phenomena, which orient themselves around the social dimensions that influence individuals¢ actions. For example, in your April 2005 article ¡No Woman (or man) is an Island in the Economy¢, you reviewed the key ideas of economic sociology and concluded that ¡economists may squirm under this critique from other social scientists but, in the end, it will do them a power of good.¢ Recent research by economic sociologists¢ suggest that mainstream economics has not yet engaged with alternative paradigms in any great capacity.

How do you view the future for mainstream economics if dialogue with other disciplines continues to be ignored?

I don’t imagine the vice is exclusive to economists, but I do accept the implication that economists generally avoid engaging with other disciplines. You might expect this isolationism to lead eventually to the decline of economics as it becomes increasingly irrelevant and isolated from the real world. But I would be loath to make such a fearless forecast for several reasons. The first is that economics is the dominant paradigm in the worlds of business and government policy-making. Its isolation from interaction with other social sciences has been the case for at least a century, but we have yet to see this leading to a decline in its influence. Because economics is the dominant paradigm, its precepts have a ring of credibility to them, even to people with no education in economics. Economics is the ideology that fits most easily with the interests of business, that tends to sanctify and the pursuit of profit, and this must surely help explain its longevity and dominance. A great intellectual attraction of economics is that it’s rigorously logical - even to the point of being capable of reduction to a set of equations - given its assumptions. When you’re good at playing mathematical games - as most academic economists are - why bother wondering about how realistic the assumptions are?

On a more positive note, the psychological critique of economics has been taking up by the behavioural economists; the psychologist founder of behavioural economics was awarded a Nobel prize in economics for his trouble, and papers on behavioural economics are appearing in many top journals. The brightest among its young devotees are setting their minds to finding ways it incorporate its insights into equations, and then its influence will be felt.

Question 3

Sociologist Michael Pusey¢s well-cited 1991 book ¡Economic Rationalism in
Canberra: A Nation-building State Changes Its Mind¢ describes how key policy makers in Canberra generally came to hold a tenacious (bordering on dogmatic) commitment to the philosophy of economic rationalism.

Do you agree with Pusey¢s argument in this respect? From your perspective, how could a consideration of alternative approaches offered by economic sociology or behavioral economics better inform and enrich public policy?

I might have a different reaction if I reread Pusey today, but at the time I wasn’t convinced by his exposition of the problem and its causes. I was annoyed by the claim - which may not have been his - that he discovered and named economic rationalism. That term had been part of my vocabulary for at least a decade before Pusey came along. I don’t believe he accurately captured the motives of the bureaucrat advocates of rationalism, nor the process by which rationalism - neoliberalism as it’s called overseas - came to have such an influence over policy. The econocrats didn’t suddenly convert to rationalism, they had always believed in it, often thinking of it as ‘the Treasury line’. It is after all, simply the taking of a missionary attitude towards the precepts of the neoclassical model.

No, the real question is why, after decades of limited success in persuading their political masters to implement rationalist policies, the Hawke-Keating government start acting on their advice with such vigour. The answer is, because the old protectionist and interventionist policies were no long working, the economy was in a state of significant malfunction - with double-digit inflation and unemployment - the politicians had to try something different and they were persuaded to implement the neoliberal policies being tried in most of the other English-speaking countries following the breakdown of the Bretton Woods fixed exchange-rate regime in the early 1970s.

The view that everything in the economy was going fine until a bunch of econocrats took it into their heads to persuade their political masters to make changes that stuffed everything up is a nostalgic rewriting of history. It remembers the halcyon 50s and 60s, but blanks out the descent into dysfunction in mid-70s to early 80s. The post-war Golden Age was brought to an end throughout the developed world by the advent of stagflation, the product of decades of naive Keynesianism and endless intervention in markets. In Australia the malfunctioning of the old policy regime was greatly compounded by the economic mismanagement of the inexperienced Whitlam government.

The adoption of rationalist policies didn’t cause the economic dysfunction, it was a later reaction to it. It’s important to acknowledge that, given its blinkered objectives, economic rationalism works. When you remove government interventions that inhibit the pursuit of economic growth, you do get more growth. A quarter of a century later we can say it has largely succeeded in restoring low inflation and low unemployment, though this has been accompanied by huge growth in household and foreign debt and some worsening in the distribution of income and wealth (though much less than is widely believed).

I don’t believe our circumstances - plus changes in the rest of the world - left us much choice but to make most of the changes we did. My regret is that, as with most reform movements, in our zeal we swept away a lot of institutions whose contribution to our wellbeing we weren’t aware of at the time.

Question 4

What particular aspects of economic sociology do you see as useful/important?

I have to be careful here not to reveal my limited knowledge of all that economic sociology has to offer. With its rational actor model, its barely concealed libertarianism, its assumption that the individual has fixed tastes and preferences utterly uninfluenced by social relationships, its preoccupation with the material, its inability to come to grips with non-monetary values and its intense focus on the price mechanism, economics - which influences the perceptions of many politicians and business people, not just professional economists - is blind to many important aspects of economic life, not to mention being blind to non-material objectives. Economists simply don’t see many of the institutions sociologists study. They often take insufficient account of the role of formal institutions such as laws; norms of behaviour they are usually oblivious to. And yet those norms affect the vigour with which firms pursue profits and the choices consumers make.

I think it’s fairly common for economic reformers to want to sweep away government interventions their model tells them are inefficient in the pursuit of economic growth, but which unknown to them are serving to reinforce institutions the community values. An example close to my heart is the deregulation of shopping hours and the push to get rid of penalty payments for work at unsociable hours. Economists saw these simply as impediments to higher productivity - which they are. It never occurred to economists that these interventions were there to ensure most of us could socialise at the weekend, an arrangement very important to us.

Another example is economists’ emphasis on the virtue of having a highly geographically mobile workforce. There’s no denying that economic growth is enhanced when employers in expanding industries in one part of the country can easily attract workers from parts of the country where industries are contracting. What simply never occurs to economists is the implication of this mobility for family relationships - for young families needing help from parents now in another city or state, or for middle-aged couples needing to assist ageing parents. When such ramifications are drawn to economists’ attention, they’re usual reaction is to say they have no expertise in this area, which is a matter for others. But this attitude doesn’t fit with the missionary attitude of economic rationalists and their unspoken proposition that economic efficiency is the only thing governments need worry about.

Then there’s the belated discovery of social capital and the truth that ‘trust’ is a valuable economic commodity which greases the wheels of a capitalist economy. In the years following financial deregulation, the banks happily exploited the loyalty (or inertia) of their customers, quietly offering new customers better deals than they were giving existing customers. Later they recoiled in amazed horror when they discovered how much their customers hated them. I’m sure they didn’t really understand the game they’d been playing. Too often, economists, politicians and business people wake up to the value of these institutions only after they’ve been damaged or destroyed.

There is a valuable role for economic sociologists to point out beforehand to policy-makers and the community generally the existence of institutions few people can see, but which are actually highly valued. Sociologists can also contribute to the public debate by pointing to the range of powerful non-monetary motivations helping to drive economic behaviour, motivations the economic model has led economists, politicians, business people and the media to disregard.

The economists’ dominance in the provision of public policy advice needs to be contested by other social scientists, who have much of value to contribute. I’m confident the politicians would soon see the value of that advice were they exposed to it. There is, however, a price to be paid if economic sociologists want to make such a contribution. There are few formal academic rewards for doing so (though sociologists should be the first to discern the unacknowledged occupational rewards as well as the personal non-monetary rewards). Sociology deals with such intangible and unfamiliar issues that all you say has to be illustrated with relevant, concrete examples. The public’s inability to see the practical applications of sociologists’ airy-fairy theorising is a major stumbling block to be overcome. And the public is so unfamiliar with sociology’s terminology and way of thinking that all you say to a lay audience must be expressed in the simplest, clearest English possible. The public suspects that all social scientists seek to conceal the prosaic nature of their findings by using a lot of jargon. If this isn’t true, you have nothing to fear by making your message as clear as possible.